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Runaway High Speed Trading -- Protect Yourself

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On September 28th, the New York Times' Business page published "Beyond Wall St., Curbs on High-Speed Trades Proceed." It shows how Australia, Canada, the European Union, France, Germany, and Hong Kong are all leading the United States in cracking down on high speed trading.

High speed trading employs computers located as close to the stock exchange computers as possible. The fastest computers use private high-speed cable rather than the Internet. Then high-speed traders employ programmers to build special algorithms (computer code) that can execute each trade in one trillionth of a second.

These "algos" are invisible to others. Algos prevent trades made by institutional investors and retail investors from taking place until the high speed traders need to sell their shares of stock that are about to fall in price.

Are "algo wars" among high speed traders causing stock exchanges and other financial markets to crash? Are algo wars increasing volatility in the market? In America, thanks to the opaqueness of the Security and Exchange Commission (SEC), it's anyone's guess. But many active traders and financial regulators in other countries believe high-speed trading is the cause of flash crashes and excessive volatility.

For example, in its Fall 2011 issue, thinkMoney/13 from TD Ameritrade's online brokerage, Think or Swim, came an article called "Beating the Machines" which talked about using specific kinds of options to protect oneself from high-speed trading. Last month Jim Cramer "slammed high-speed trading" on his Mad Money TV show. The Motley Fool, one of the earliest web sites to promote trading by the small investor, just asked "Can High-Speed Trading Be Slowed Down?"

We may well ask, "What did the Securities and Exchange Commission do when it realized the danger to other investors from high-speed trading? Did it warn the American people? Order high speed trading to cease? Ban algorithms designed to cheat other investors?" Absolutely not!

The SEC's response to high speed trading

This week, acceding to the New York Times article cited above, the SEC will host a roundtable to discuss high-speed trading, but the agency has passed no laws regarding speed trading this year.

In fact, from what I've read in the financial news, the SEC continuously minimizes the daily theft at the stock exchanges by using obfuscatory words like "flash crashes," "glitches," and "circuit breakers." These words downplay the damage being done to millions of Americans' pocketbooks and make the solution to this fraud seem easy.

In his book, Dark Pools: High-Speed Traders, A.I. Bandits, and the Threat to the Global Financial System (2012) Scott Patterson, author of the New York Times bestseller, The Quants, alleges that SEC knew what high-speed traders were up to after the May 2010 Flash Crash shocked the stock market.

According to Dark Pools (page 291) the SEC went to Congress asking for millions of dollars (during a severe recession!) to build a giant high-speed trading system of its own called CAT (Consolidated Audit Trail). This is apparently what it means by installing a "circuit breaker."

How will the SEC ever be able to keep up with all those high-speed con men? The SEC couldn't even catch Frankel and Madoff! it's a good bet the SEC certainly won't stop high-speed-trading rogues either! Apparently, all the SEC plans to do about high speed trading is use even more taxpayer monies to clean up the messes that speed traders make when they continue to stir up and crash the markets while cheating other investors.

What should you do?

Understand this. There are now three different trading models: (1) "high speed trading"; (2) "dumb money" (buy-and-hold big cap, blue chip, dividend-paying stocks), and (3) "active trading" (buy and sell relatively unknown small cap stocks (ala Cramer's Mad Money methods or Phil Town's Rule #1 of Investing.)

Retail traders, the buy-and-hold crowd, are fleeing the stock market in droves. The crashes and unexpected volatility in the markets are too much to deal with. Will QE3 get those investors back into the markets to lose even more money to high-speed traders while the SEC twiddles thumbs?

What about institutional investors? This includes our private and public pension funds and insurance companies' 401K funds. Some are going high speed; others are simply going broke.

Without "dumb money" and institutional trading to "make their days," high-speed traders can only make money from the fees stock exchanges pay them for trading.

Speed traders will lose profits on trading itself. High-speed traders prefer to trade "high-float" stocks. High-float stocks have large numbers of shares available to sell each day. High-float stocks tend to be the blue chip, large-cap company and dividend-paying stocks that buy-and-hold retail investors and institutional investors trade in.

What about active traders then? Active investors tend to stick with low-float, small cap stocks. Active traders also believe in continuous financial education. As a result, many are still making money on the stock market.

What about you? Push for SEC protection, but don't hold your breath waiting for it! Get a copy of Dark Pools. Start learning about the dangers of high-speed trading. Talk too to your broker, pension fund, and/or 401K owner! Find out how (if) they can protect your money from high-speed algorithms. Then act quickly. Protect your money!